Bracing for the Fed

The stock market will likely trade cautiously ahead of the Kansas City Fed's Jackson Hole Conference on August 26-28.  The Fed Chair's speech at this annual conference sometimes announces intentions to change monetary policy.  So, the markets will probably brace for an announcement about an intention to taper in the near term.  They will be looking for hints to this effect in this Wednesday's release of the July FOMC Meeting Minutes -- although they are not likely to find much, given that Fed Chair Powell's post-meeting conference did not provide any new insights.  In the background, concern about the negative effects of the Delta virus variant could weigh on stocks.  But, this concern should be mitigated if upcoming US economic data continue to point to strong growth.

This week's US economic data releases will touch on the consumer, manufacturing and construction sectors.  Consensus looks for -0.3% m/m Total and +0.2% Ex Auto Retail Sales for July.  A small decline or increase is typical after a strong Sales gain as in June (+0.6%Total, +1.3% Ex Auto).  So, any commentary attributing a soft print to the virus should be viewed dubiously.  The July Employment Report showed job gains in most Retail categories, suggesting Retail Sales remain in an uptrend.  

Consensus looks for a +0.5% m/m increase in July Industrial Production and, within it, Manufacturing Output.  The risk is for an even larger gain in the latter, as the consensus estimate does not appear to take account of a productivity gain this month -- the expected Output increase equals the increase in Total Hours Worked in manufacturing.  What could be important for the stock market if this report suggests the chip shortage is ending in the motor vehicle sector.  The clue will be whether Motor Vehicle Assemblies increase m/m.

Consensus expects a dip in July Housing Starts but an increase in Permits.  A dip in Starts could be just a lagged reflection of the decline in Permits in June.  So, if Permits rebound in July, the decline in Starts should be dismissed as temporary. That said, the housing sector has a problem.  The Affordability Index (based in part on Existing Home Prices) has been declining all year because of the surge in home prices.  Since March, the Index has dropped to its lowest  level since 2018 despite the benefit of lower mortgage rates.  The risk is for a shift to rentals from 1-Family purchases, which could hurt construction activity.  Higher rents will eventually show up in the CPI, while home prices could soon be coming down.

Door Open for Fed Tapering

The strong July Employment Report increases the risk of the Fed cutting back its bond buying program before year-end.   Economic growth and the labor market are on solidly positive paths, allowing Fed officials to say they're seeing "substantial further progress" toward their "maximum employment" goal.  Officials will have many speech opportunities to inform the markets of a policy shift in coming weeks, as the next FOMC meeting is on September 21-22.  But, with the Unemployment Rate still well above pre-pandemic lows and inflation looking as if it will soon come off its extraordinary high pace, a Fed rate hike is likely a long way off.  Indeed, the increased chances of tapering could put additional downward pressure on commodity prices.  The markets' reactions to tapering will likely be muted as a result.

The July Employment Report was strong.  The +943k m/m surge in Nonfarm Payrolls is mostly attributable to Leisure & Hospitality (+380k) and State & Local Education Jobs (+231k).  But, even without these post-pandemic bounce-backs, Payrolls rose a strong 332k.  Moreover, June and May Payrolls were revised up.  The surge in jobs was also seen in the 1.0 Mn jump in Civilian Employment.  This swamped the moderate increase in Labor Force, so the Unemployment Rate dropped to 5.4% from 5.8%.  Total Hours Worked in July stand 4.3% (annualized) above the Q221 average, pointing to another strong Real GDP Growth in Q321.  The Atlanta Fed model's latest projection is 6.0% (q/q, saar), similar to the 6.5% growth rate in Q221.

While it is too soon to draw a conclusion about the risks to the August Employment Report, the early evidence from the Claims data suggests another strong report.  Specifically, the -366k w/w drop in Continuing Claims to 2.930 Mn, a new low for the move down, suggests a speedup in hiring.

Despite the strong growth, inflation may be moving down toward the Fed's target of 2%.  Consensus looks for +0.4% m/m Total and +0.5% Core in this week's July CPI report.  They are about half the June pace (+0.9% each).  Some of the culprits for the recent large increases -- used car prices, gasoline prices -- have begun to flatten.  The July report may be too soon to see the full extent of the flattening, however.  So a further deceleration in coming months is a good possibility.

Labor Costs are moving up, but they too may be starting to moderate.  Although Average Hourly Earnings were higher than expected in July, +0.4% m/m after an upward-revised 0.4% in June (was +0.3%), they were slower than the 0.5-0.7% seen in April and May.  Wages rose the most in sectors with labor shortages -- Leisure & Hospitality and Transportation/Warehousing sectors.  Wage pressures in these sectors may begin to ease in September when the ending of supplemental Unemployment Benefits may induce an increase in labor supply.  This week's report on Q221 Unit Labor Costs will show whether Productivity Gains are offsetting the higher wage inflation.  Consensus looks for a slowdown in ULC to 1.2% (q/q, saar) from 1.7% in Q121, which is in the right direction from an inflation perspective.

Risks in This Week's Key US Economic Data

The stock market will be focusing on key US macroeconomic data this week -- the July Mfg ISM and Employment Report.  The risk is for both to come in softer than consensus.  Such prints could be a positive for stocks, as they would argue against an early start to Fed tapering.  Away from the data, the market needs to see Congress hike the debt ceiling by the end of Monday.  A short-term moderate-sized hike would seem to be a likely outcome, as the two "infrastructure" proposals appear to be far from approval.

Consensus looks for a speedup in July Nonfarm Payrolls to +900k m/m from +850k in June.  The Claims data, however, don't suggest a jobs speedup.  The 4-week average of Initial going into the July Payroll Survey Week was about the same as it was going into the June Survey Week -- 387k versus 396k.  This suggests the pace of layoffs did not change much.  It is possible that some of the chip-shortage vehicle plant shutdowns could subtract from Payrolls this month.  And, the decline in Continuing Claims between Survey Weeks was smaller in July than in June, suggesting not as many people returned to work in July as in June. 

Consensus also looks for a 0.2% pt m/m decline in the Civilian Unemployment Rate to 5.8% in July from 5.9% in June.  The Insured Unemployment Rate, which is based on Continuing Claims, does not rule this out.  The Insured Rate edged down 0.1% pt for the 2nd month in a row.  There could be catchup by the Civilian Unemployment Rate after it rose in June, contrary to the Insured Rate.  But, there is a lot of uncertainty regarding the Labor Force Participation Rate.  If many people are encouraged to re-enter the labor market, the Participation Rate would increase and work to lift the Civilian Unemployment Rate if the re-entrants don't have jobs yet.

Consensus expects a moderate 0.3% m/m in July Average Hourly Earnings.  While the y/y would rise to 3.9% from 3.6% in June, this m/m pace would suggest the speedup in labor costs is not excessive yet.  The slowdown in the Q221 Employment Cost Index, reported last week, was encouraging in this regard.

Consensus sees a uptick in the Mfg ISM to 60.9 in July from 60.6 in June.  Evidence from other surveys is mixed.  Markit Mfg PMI, Empire State Mfg,  and Chicago PM rose, but Phil Fed Mfg Index fell.  None of these has tracked the m/m direction of the Mfg ISM reliably.  So, a decline cannot be ruled out.  The chip shortage problem could weigh on this Index, although the latter doe not tend to be dominated by the motor vehicle industry.

A Fiscal Threat, This Week's US Economic Data and the Fed

Developments in Washington may soon create a hurdle for the market.  Neither the bi-partisan infrastructure proposal nor Biden's so-called infrastructure proposal is the issue.  It is still not clear that either will pass.  And, if they do, the specifics of the associated tax hikes and spending path are needed to tell whether the markets need to tighten or not in the near term as an offset.  The more immediate issue is whether a hike in the debt ceiling will be passed without a problem, with August 2 being the deadline.  Will passage happen seamlessly or be delayed, the latter forcing the Treasury to implement "extraordinary measures" to finance the government? A delay would risk a US dollar downgrade, which would be a negative for the stock market. 

While the ceiling will be hiked eventually, the amount bears on whether the infrastructure proposals are made into law.  A large hike could be needed if the increased spending is not sufficiently offset by higher taxes.  Republicans would likely be highly reluctant to vote for a large hike, knowing it would effectively ratify the proposals.  So, a vote on the debt ceiling risks being a last-minute affair.  And, the likely outcome will be a small hike for a short period, thereby kicking the issue down the road -- possibly until the specifics of the proposals are known.  This result should solve the immediate problem for the stock market.  But, if it is not achieved before the August 2 deadline, stocks could sell off sharply, albeit temporarily.

Away from developments in Washington, strong corporate earnings reports and US economic data should continue to support the stock market.  This week's economic data are expected to post good-sized gains, although there is downside risk to some of the less important ones.

Consensus looks for a 3.5% m/m rebound in June New Home Sales, but the risk is for a decline -- as was the case with June Housing Permits.  Consensus sees an increase in June Durable Goods Orders, +2.1% m/m Total and +0.8% Ex Transportation.  But, chip shortages and more subdued prices could hold down the gain.  

More importantly, consensus expects an even larger speedup in Q221 Real GDP Growth than does the Atlanta Fed model -- +8.6% (q/q, saar) versus +7.6%.  (Real GDP Growth was 6.4% in Q121.)  And, consensus sees Initial Claims reversing last week's reported jump.  If they do, it would signal that above-trend growth continues in Q321.

On Friday, consensus looks for a 0.7% m/m jump in June Consumer Spending.  Spending strength was already seen in the Retail Sales data, but a jump in this broader measure should bolster confidence in the consumer sustaining strong growth ahead.  The June PCE Deflator is expected to be high, as well, with the Core up 0.6% m/m.  A high inflation print was already seen in the June CPI.   Consensus looks for a large  0.9% q/q increase in the Q221 Employment Cost Index, matching the prior quarter's jump.  It is too soon to be concerned about a sustained speedup in labor costs, however.  Large wage increases could be just temporary adjustments to the economy's re-opening.  It will become a problem regarding inflation if higher wage inflation persists in H221.

This week's FOMC Meeting should not be a problem for the stock market.  The Statement and Fed Chair Powell's post-meeting comments will likely underscore the intent to keep monetary policy aimed at promoting economic growth and the belief that the recent jump in inflation is temporary.  The drop in longer-term Treasury yields since the last meeting supports these ideas.

Stock Market Has Two Fears

The stock market may need to get through two fears before moving up again -- fear that the recent high inflation prints won't be temporary and fear that economic growth will slow sharply.  Both fears are probably overdone, but may take more evidential support to become subdued.  In particular, commodity prices need to continue to fall, while economic evidence remains strong.

There is little question that the latest high CPI print was largely a result of just a few items.  Two-thirds of the 0.9% m/m jump in the June Core CPI were accounted for by 4 components -- Used Cars, Hotels, Airfares and New Vehicles.  Their large increases can be explained by chip shortages, higher oil prices and an adjustment to the economy's reopening.  All these factors are likely temporary, but could take time to unwind.  For example, once the chip shortage ends, Used Car Prices will likely fall.

Regarding the overall CPI, food prices surged 0.8% while energy prices jumped 1.5%.   Higher transportation costs could have been behind the jump in food prices, at least in part, reflecting a pass-through of higher gasoline prices and higher truckers' wages (stemming from labor shortages, in part, possibly due in part to the disincentive effect of extended unemployment benefits).   Oil prices now appear to be stabilizing after OPEC agreed to a production hike.  So, their impact on inflation should abate in coming months.  The higher food and energy prices are probably behind the drop in the Mid-June University of Michigan Consumer Sentiment Index.  They hurt consumer purchasing power.  For example, the $15/bbl run-up in oil prices since March, if fully passed through, was equivalent to a $100 Bn tax hike (annualized) on the consumer.  

So far, the US economy looks to be growing above trend, although to a lesser extent than in H121.  Data in the first week of August -- July Employment Report and July Mfg ISM -- could be important evidence to this effect.  Unemployment Claims have resumed their downtrends, consistent with above-trend growth.  If they fall further in the next couple of weeks, they will point to a strong July Employment Report.  The latest manufacturing surveys were mixed, with Phil Fed Mfg Index down (but still at a good level) and NY Empire State Mfg Index up to a new high.  While none of these regional surveys is a reliable predictor of the Mfg ISM, the Empire State has done a better job than Phil Fed so far this year.

Weakness in manufacturing appears to be related to shortages, particularly chip shortages for the motor vehicle industry.  The 0.1% m/m decline in June Mfg Output (in the Industrial Production Report) was largely due to a drop in Motor Vehicle Assemblies.  Ex Motor Vehicles, Manufacturing Output rose 0.4%, the same as the average pace over the first 5 months of the year -- and a very decent pace from an historical perspective.   The chip shortage is setting up the motor vehicle industry for a major rebound in output at some point.

 

 

Should Low Long-Term Yields Be A Concern?

The stock market now views lower longer-term Treasury yields as a negative, signaling problems ahead.  This concern may be overdone, however.  The primary problem appears to be fear of a significant global economic slowdown, according to news analysis.  A dissipation of the boost to growth from US fiscal stimulus, fear of renewed restrictions in response to the Delta coronavirus variant, an apparent decline in the chances for more US stimulus as the Biden proposal has questionable support, and the decline in a number of commodity prices are possible reasons for the concern.

However, there are reasons to think that fear of a sharp slowdown is overdone.  Central banks support a continuation of strong economic growth.  Last week's release of the June FOMC Minutes suggested most Fed officials do not think the economic has improved enough to warrant even discussion of a tapering of Treasury/MBS purchases in the near term.  Fed Chair Powell should reiterate the Fed's commitment to support growth in his Semi-Annual Monetary Policy Testimony this week.  The Chinese central bank appears to have eased a bit late last week, even though it called its rate cut technical.  As for the coronavirus, the Delta variant does not seem to have as severe effects as earlier versions.  Moreover, some vaccines are said to provide protection against it, while boosters are being developed to directly target this latest variant, as well.  It is highly unlikely that a resurgence of the virus this fall will prompt state governments to impose significant restrictions on economic activity.

To be sure, a slowdown in US economic growth from the exceptional speed of re-opening has been the risk.  A slowing over Q221, even as the q/q growth remained strong, was projected in my May 16 blog ("Economic Growth Strong and Slowing At Same Time").  Nevertheless, growth is likely to remain above trend, although not by as much in H121.  Company surveys showed good momentum in US and global growth as the quarter ended.  The Markit PMI and ISM Indexes remained at high levels in June, as did other surveys.  US job growth was strong.  And, while Total Hours Worked slowed, they are set up for solid growth in Q321 (see last week's blog).  

Last week's release of Unemployment Claims data disappointed the stock market, as Initial Claims came in well above the consensus estimate.  But, in fact, the Claims data show an improving trend in labor market conditions, despite the uptick in Initial Claims in the latest week.  While the downtrend in Initial has slowed since May (see table below), the downward direction still indicates above-trend economic growth.  And, the downtrend in Continuing Claims shows a renewed speedup and hints at increased hiring -- possibly because a number of states ended the supplemental benefits (thus persuading people to accept jobs rather than stay on benefits).

This week's US economic data are expected to be consistent with a moderation in economic growth.  Consensus look for +0.7% m/m in June Industrial Production, with Manufacturing Output up 0.3%.  The latter would be a sharp slowdown from May's +0.9%.  Moreover, there is downside risk, based on Total Hours Worked.  Consensus looks for +0.5% m/m in June Ex Auto Retail Sales.  This does not fully unwind the -0.7% in May, although there is upside risk from higher prices.  Consensus looks for high prints for the June Core CPI (+0.4% m/m) and Core PPI (+0.5%).  These estimates are high enough to leave open the door for a smaller print, however. 

(m/m change, 000s)

Initial Claims  Continuing Claims

Jan 21 +19 -439

Feb -62 -483

Mar -74 -481

Apr -93 -196

May       -184   -22

Jun         -49 -213

Jul (1st week) -22 -104*

*last week of June less June average

 

 

 

The June Employment Report, Fed and Q221 Corporate Earnings

The markets will likely focus on this week's release of the June FOMC Minutes for clues on when the Fed will begin discussing the start of tapering.  They may not get much hint.  It is more likely that any discussion of the issue will be general in nature.  The Fed leadership appears committed to eliminating the pandemic-induced labor market slack and a significant move in that direction may be necessary to spur a change in policy.  The June Employment Report did not show this to be the case as yet.  Meanwhile, the corporate earnings season is beginning and expectations are strong.

The June Employment Report should keep the Fed on hold.  The Unemployment Rate edged up to 5.9% from 5.8%, with small increases in most sub-groups.  There was a dip in Civilian Employment, while the Labor Force rose slightly.  The minor changes in both could reflect the small sample bias in the Household Survey, but the bias drops out in the calculation of the Unemployment Rate.  So, it is fair to say the Rate was up slightly, counter to the Fed's goal of driving the Rate down to pre-pandemic levels.  Currently, the Unemployment Rate is 2+ percentage points above the pre-pandemic low.

While Payrolls surged +850k, 230k came from State & Local Government Education jobs.  It looks like seasonals were behind their jump.   Seasonals expected to offset a drop in these jobs as the school year ended.  But, since schools were mostly closed for in-class teaching, many of these jobs were not there to begin with -- and therefore did not drop out (nsa) in June as seasonals expected.  Most of the remainder of the Payroll increase came from re-openings of restaurants and hotels and retail jobs.

Labor cost inflation appears to be contained.  Average Hourly Earnings slowed on a m/m basis for the 2nd month in a row.  The 0.3% m/m increase is just slightly above the 0.1-0.2% pace seen before the pandemic.

The decline in the Nonfarm Workweek to 34.7 Hours from 34.8 Hours in May -- the second m/m decline in a row -- held down the increase in Total Hours Worked to 0.2% m/m.   The latter raises the possibility of slower GPD Growth in Q321.  The June level of THW is 0.7% (annualized) above the Q221 average.  If THW climbs 0.2% m/m in each of the past 3 months, then THW will have risen 2.4% (q/q, saar) in Q221, versus +4.5% in Q221.

Consensus looks for a huge 60+% y/y increase in Q220 S&P 500 corporate earnings.  Base effects account for most of the gain, as the bounce represents a recovery from the economic shutdown to a large extent -- as was the case with GDP.   The level of earnings per share would be about 6% above the pre-pandemic peak.  Besides the re-opening bounce in GDP, other macro factors helped the earnings recovery, as well.  Oil prices rebounded, pointing to large gains for this sector's profits.  The dollar weakened as the "flight to safety" unwound.  This lifted the dollar value of earnings abroad, which also should have been helped by economic recoveries in other countries.  And, while compositional shifts have distorted Average Hourly Earnings and CPI, profit margins may have improved. 

                                                                                                                                          Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level)
Q119            3.2                -12.8                 +7.9                             3.2           2.1               51.9 
Q219            2.7                -12.2                 +5.9                             3.1           2.1               47.8    
Q319            2.1                -19.2                 +3.6                             3.2           2.3               46.4
Q419            2.4                  -3.6                 +1.7                             3.2           2.3               46.2

Q120           -5.0                -16.5                 +2.9                             3.1           2.3               47.2

Q220         -10.6                -53.5                 +5.9                             6.5           1.4               40.1

Q320           -2.8                -27.8                 +1.0                             4.8           1.7               52.4

Q420           -2.4                -25.5                  -1.9                             4.8           1.6               54.6

 

Q121            0.4                  26.3                 -4.4                              4.9           1.4               58.3   

Q221          12.4 *               32.1                 -8.3                              1.2           3.4               63.1                                                                     

         

* Based on the Atlanta Fed Model's latest projection of +7.8% (q/q, saar).